Definition
A “down round” is a financing round where investors buy share of a company at a lower valuation than the preceding round, suggesting that a company’s value has decreased. This often occurs when a company has struggled with performance issues. It can dilute shares held by existing investors and even alter control or decision-making power within the company.
Key Takeaways
- Down Round refers to a financing event where the company issues additional shares at a lower valuation than in the previous funding round. This usually happens when a company’s valuation has dropped due to poor performance or market conditions.
- This financing strategy can have significant implications for previous investors and the company’s founders as it often dilutes their equity. Shareholders’ ownership percentage decreases, and it can adversely affect the company’s ability to attract future investors given its apparent depreciation in value.
- Although a Down Round might seem negative due to dilution and devaluation, it can sometimes be necessary for a company to survive. Providing the necessary capital for enterprises to continue operations and possibly restore their value can be significant. So despite its potential drawbacks, a Down Round can keep a company afloat in times of financial difficulties.
Importance
A “Down Round” is a significant finance term and often critical in the venture capital industry. It refers to a funding round where a company raises capital at a lower valuation than in its previous round.
This usually occurs when a company fails to meet certain business milestones or market expectations or during economic downturns. For investors and shareholders, a down round could lead to ownership dilution and potentially less return on their investment.
For the company, it could affect morale and make it more challenging to attract future investors. Therefore, understanding the concept of a down round is essential for assessing business performance and financial risk.
Explanation
A down round is a practical tool utilized in venture financing, designed to provide companies, predominantly startups, with financial support when they’re struggling or encountering adverse market conditions. In essence, it’s engineered to address a company’s immediate capital needs to keep operations running smoothly, especially when the company is not doing well financially.
A down round might be used to aid new business ventures that have not yet acquired a steady revenue stream or when a company’s value has significantly dropped. Furthermore, the principle behind a down round is to buoy a company’s stability during challenging times as it allows for the collection of funds at a lower valuation of the company’s worth.
This involves the issuance of shares at a price lower than the price in the previous funding round. While businesses prefer to avoid a down round as it can dilute the value of previously issued shares and be a sign of trouble to investors, it nevertheless offers an essential lifeline for companies in need of capital, and can sometimes be a catalyst for future success and growth.
Examples of Down Round
**Snap Inc. Down Round**: In March 2017, Snap Inc., the parent company of Snapchat, went through a down round during its Initial Public Offering (IPO). Snap Inc. had previously raised private money at about $81 a share. However, during its IPO, the company only managed to sell its shares at $17, marking a down round.
**Uber’s Down Round in 2020**: $Uber, a popular ride-sharing company, experienced a down round in 2020 when it received a $500 million investment from Greenbriar Equity Group. The valuation of $2 billion for the Advanced Technologies Group of Uber was significantly lower than the valuation given in a funding round in 2019, which was $
25 billion.**Square’s Down Round**: Payments company Square experienced a significant down round upon going public. At its IPO in 2015, Square’s initial public offering price was $9 a share, well below the $
46 price it sold shares at in its last private fundraising round inThe valuation instantly shrank by about 30 percent.
FAQs for Down Round
What is a Down Round?
A down round is a round of financing where investors purchase equity from a company at a lower valuation than the valuation placed upon the company by earlier investors.
Why would a company have a Down Round?
A company might have a down round for a number of reasons, but it typically boils down to the fact that the company has not been able to achieve the milestones or growth that was anticipated, and its perceived value has decreased as a result.
What is the impact of a Down Round for existing shareholders?
For existing shareholders, a down round typically results in dilution of their equity stake. It can also decrease their voting power in the company, and potentially reduce their returns upon exit or at liquidity events.
How can a Down Round be avoided?
Avoiding a down round usually involves proper planning and management, particularly in terms of setting realistic valuation expectations and achieving the projected development or growth milestones. Also, it requires consistent communication with and managing expectations of existing shareholders and potential investors.
Can a company recover from a Down Round?
Yes, companies can and do recover from down rounds. The impact can be mitigated by factors such as the company’s ability to turn the business around, improve its performance and once again increase its value.
Related Entrepreneurship Terms
- Equity Financing: It’s a type of financial funding where companies raise capital by selling shares of their company. Down rounds occur during equity financing when companies sell their stock at a lower price.
- Venture Capital: This is a financial investment in a startup or small business that appears to have long-term growth potential. Investors face the risk of a down round if the startup performs poorly.
- Initial Public Offering (IPO): It’s the first time a private company offers its shares for sale to the general public. If the company’s valuation falls, it may lead to a down round in the next equity financing round.
- Pre-Money Valuation: This is the company’s estimated value before receiving external financing or conducting an IPO. A lower pre-money valuation can trigger a down round.
- Dilution: This is the decrease in existing shareholders’ ownership percentage of a company due to the company issuing new equity. It’s common in a down round as new shares are sold at a lower price, potentially causing significant dilution.
Sources for More Information
- Investopedia: This financial education website provides easy-to-understand explanations of various finance concepts, including Down Round.
- Entrepreneur: This site offers articles related to different areas of business and could have detailed explanations and discussions about Down round.
- Financial Times: This international business news website includes topical finance issues and terms.
- MarketWatch: This financial information website provides business news, analysis, and stock market data, and might have articles that discuss Down Round.
